Annual Report

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

 

 

Commission file number 000-32369

 

 

 

(404) 459-4450

 

Registrant’s telephone number, including area code:

 

Securities registered pursuant to Section 12(b) of the Exchange Act: None

 

Securities registered pursuant to Section 12(g) of the Exchange Act:

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes  o      No  þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ      No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  Yes  þ      No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer  o      Accelerated filer  þ      Non-accelerated filer  o

 

Indicate by check mark whether the registrant is shell a company (as defined in Exchange Act rule 12b-2).  Yes  o      No  þ

 

As of July 9, 2006 (the last day of the registrant’s second quarter for 2006), the aggregate market value of the registrant’s voting common stock held by non-affiliates of the registrant, based on the closing sale price as reported on the Nasdaq Global Market System, was approximately $366,449,268.

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

Documents incorporated by reference:   Portions of our 2007 Proxy Statement are incorporated herein by reference in Part III of this Annual Report.

 

 

 

AFC ENTERPRISES, INC.

 

INDEX TO FORM 10-K

 

 

 

 

AFC Enterprises, Inc. (“AFC” or “the Company”) develops, operates, and franchises quick-service restaurants (“QSRs” or “restaurants”) under the trade name Popeyes ^® Chicken & Biscuits (“Popeyes”). Within Popeyes, we manage two business segments: franchise operations and company-operated restaurants. Financial information concerning these business segments can be found at Note 24 to our Consolidated Financial Statements.

 

In recent years, we have narrowed our business model from a multi-brand operator to focus only on the Popeyes brand. Following the sale of Church’s Chicken ^® (“Church’s”) in December of 2004 (which is more fully described in Note 22 to our Consolidated Financial Statements), we renegotiated our material outsourcing contracts, closed our AFC corporate offices, reduced our AFC corporate staffing, and integrated the remaining AFC corporate staff and services into Popeyes’ business operations (which is more fully described in Note 23 to our Consolidated Financial Statements). These transitional activities were completed during 2005 and the first half of 2006.

 

Popeyes Profile

 

Popeyes was founded in New Orleans, Louisiana in 1972 and has grown to be the world’s second largest quick-service chicken concept based on the number of units. Within the QSR industry, Popeyes distinguishes itself with a unique “New Orleans” style menu that features spicy chicken, chicken sandwiches, chicken strips, fried shrimp and other seafood, jambalaya, red beans and rice and other regional items. Popeyes is a highly differentiated QSR brand with a passion for its New Orleans heritage and flavorful authentic food.

 

As of December 31, 2006, we operated and franchised 1,878 Popeyes restaurants in 44 states, the District of Columbia, Puerto Rico, Guam and 24 foreign countries. The map below shows the concentration of our domestic restaurants, by state.

 

 

Of our 1,503 domestic franchised restaurants, approximately 70% were concentrated in Texas, California, Louisiana, Florida, Illinois, Maryland, New York, Mississippi, Georgia and Virginia. Of our 319 international franchised restaurants, approximately 67% were located in Korea, Indonesia, Canada and Mexico. Of our 56 company-operated restaurants, more than 90% were concentrated in Georgia, Louisiana and Tennessee.

 

Overall Business Strategy

 

United States restaurant industry sales exceeded $500 billion in 2006, of which sales from Popeyes restaurants represent a small fraction. Given the size of the domestic QSR industry, and Popeyes’ broad appeal, we believe Popeyes’ 1,559 restaurant domestic system has the potential to at least double in size without reaching saturation in

our markets. The success of Popeyes outside the United States indicates that the Popeyes international system can expand substantially as well, perhaps outpacing restaurant growth domestically in future years.

 

Because of Popeyes’ distinctive menu and our opportunities to further penetrate existing and new markets, the Company’s business strategy centers on increasing the number of restaurants in the global Popeyes’ system. Popeyes is heavily franchised (97% of all Popeyes’ restaurants are operated by our franchisees). We favor this business model because it facilitates the simultaneous growth of the system in multiple markets and provides our investors with an attractive return on invested capital from a dependable and diversified royalty stream.

 

In order to accomplish Popeyes’ growth objectives, the Company is focused on improving the unit economics of the Popeyes system restaurants with business initiatives tailored to enhance the experience of Popeyes’ guests and to promote new restaurant development.

 

These initiatives are as follows:

 

 

During 2007, we plan to strengthen our focus on value offering tests, as we believe that will broaden our appeal in a variety of markets.

 

 

We believe that the cleanliness, freshness and appearance of our restaurants are critical components of our customers’ overall dining experience and will affect their desire to return. As of December 31, 2006, approximately 76% of our system-wide restaurants have been updated in our Heritage image. We believe our distinctive New Orleans inspired Heritage design adds to our customers’ dining experience and improves the appeal of our restaurants.

 

 

 

To further stimulate growth during 2006, we offered financial incentives to franchisees to accelerate new restaurant openings through temporary reductions in franchise fees and royalties. By accelerating the timing of restaurant openings and through stimulating incremental openings, we expect to expedite revenue growth. Our franchisees opened 29 new restaurants during 2006 under this incentive program, and we expect continued acceleration of openings under this program during 2007.

 

Key to Popeyes continued restaurant growth is the cultivation of a rich pipeline of qualified franchisee candidates, composed of both existing franchisees and new franchisees. During 2007, we will accelerate recruitment of new, qualified franchisees. In addition, we continue to develop existing strategic markets by assisting our current franchise operators in their efforts to identify and secure attractive new restaurant sites.

 

Internationally, we anticipate substantial growth in new restaurants in Canada, Mexico, Latin America and the Middle East. Our intention in international markets is to enter into area franchise development agreements with franchise operators who already have multi-unit restaurant operating experience, preferably with international QSR brands. We will target franchisees who have the ambition, experience and infrastructure to effectively secure good restaurant sites and execute the Popeyes brand in their countries. Our international leadership and field support team members comprise a cross-functional group responsible for developing prospective franchisees, tailoring the Popeyes menu and operational methods to the consumers in each respective country and coordinating significant ongoing franchisee support.

 

During 2006, our initiatives allowed us to achieve growth in same-store sales and new restaurant openings. As a result, cash generated from our Popeyes operations has been used for the benefit of our investors (1) to repurchase shares of our outstanding common stock, (2) to reduce the portion of our long-term debt that is subject to a floating interest rate which trended upward during the year, (3) to reinvest in the Popeyes brand through the construction of new restaurants in company-controlled markets, and (4) to acquire existing Popeyes restaurants to provide additional company-operated test markets for our new menu items and promotional concepts to, in turn, help strategically fuel the overall growth of the Popeyes’ system.

 

As it concerns the expected financial and operating impacts of these strategies during 2007, see the discussion under the heading “Operating and Financial Outlook for 2007” at Item 7 of this Annual Report.

 

The following features of the Company are material to the execution of our initiatives and business strategies discussed above:

 

Our Agreements with Popeyes Franchisees

 

As discussed above, our strategy places a heavy emphasis on increasing the number of restaurants in the Popeyes system through franchising activities. The following discussion describes the standard arrangements we enter into with our Popeyes franchisees.

 

Domestic Development Agreements.   Our domestic franchise development agreements provide for the development of a specified number of Popeyes restaurants within a defined geographic territory. Generally, these agreements call for the development of the restaurants over a specified period of time, usually three to five years, with targeted opening dates for each restaurant. Our Popeyes franchisees currently pay a development fee of $7,500 per restaurant. These development fees typically are paid when the agreement is executed, and are typically non-refundable.

International Development Agreements.   Our international franchise development agreements are similar to our domestic franchise development agreements, though the development time frames can be longer and the development fees generally can be as much as $15,000 for each restaurant developed. Depending on the market, limited sub-franchising rights may also be granted.

 

Domestic Franchise Agreements.   Once we execute a development agreement, approve a site to be developed under that agreement, and our franchisee secures the real property for a restaurant, we enter into a franchise agreement with our franchisee that conveys the right to operate the specific Popeyes restaurant at the site. Our current franchise agreements generally provide for payment of a franchise fee of $30,000 per location.

 

These agreements generally require franchisees to pay a 5% royalty on net restaurant sales. In addition, franchisees must contribute to national and local advertising funds. Payments to the advertising funds are generally 3% of net restaurant sales. Some of our institutional and older franchise agreements provide for lower royalties and advertising fund contributions. These agreements constitute a decreasing percentage of our total outstanding franchise agreements.

 

International Franchise Agreements.   The terms of our international franchise agreements are substantially similar to those included in our domestic franchise agreements, except that these agreements may be modified to reflect the multi-national nature of the transaction and to comply with the requirements of applicable local laws. Our current international franchise agreements generally provide for payment of a franchise fee of up to $30,000 per location. In addition, the effective royalty rates may differ from those included in domestic franchise agreements, and generally are lower due to the greater number of restaurants required to be developed by our international franchisees.

 

All of our franchise agreements require that our franchisees operate restaurants in accordance with our defined operating procedures, adhere to the menu established by us, and meet applicable quality, service, health and cleanliness standards. We may terminate the franchise rights of any franchisee who does not comply with these standards and requirements.

 

Site Selection

 

For new domestic restaurants, we assist our franchisees in identifying and obtaining favorable sites consistent with the overall market plan for each development area. Domestically, we primarily emphasize freestanding sites and “end-cap, in-line” strip-mall sites with ample parking and easy access from high traffic roads.

 

Each international market has its own factors that lead to venue and site determination. In international markets, we use different venues including freestanding, in-line, food-court and other non-traditional venues. Market development strategies are a collaborative process between Popeyes and our franchisees so we can leverage local market knowledge.

 

Suppliers and Purchasing Cooperative

 

Suppliers.   Our franchisees are required to purchase all ingredients, products, materials, supplies and other items necessary in the operation of their businesses solely from suppliers who have been approved by us. These suppliers are required to meet or exceed strict quality control standards, and they must possess adequate capacity to supply our franchisees’ reliably.

 

Purchasing Cooperative.   Supplies are generally provided to our domestic franchised and company-operated restaurants pursuant to supply agreements negotiated by Supply Management Services, Inc. (“SMS”), a not-for-profit purchasing cooperative. We, our Popeyes franchisees and the owners of Cinnabon bakeries hold membership interests in SMS in proportion to the number of restaurants owned. As of December 31, 2006, we held one of SMS’s seven seats on the SMS board of directors. Our Popeyes franchise agreements require that each franchisee join SMS.

 

Supply Agreements.   The principal raw material for a Popeyes restaurant operation is fresh chicken. Company-operated and franchised restaurants purchase their chicken from suppliers who service the Popeyes system. In order to ensure favorable pricing and to secure an adequate supply of fresh chicken, SMS has entered into

supply agreements with several chicken suppliers. These contracts, which pertain to the vast majority of our system-wide purchases, are “cost-plus” contracts with prices based partially upon the cost of feed grains plus certain agreed upon non-feed and processing costs. These contracts include volume purchase commitments that are adjustable at the election of SMS. Each year, purchase commitments may be adjusted by up to 10%, if notice is given within specified time frames; and the commitment levels for future years may be adjusted based on revised estimates of need. The Company has agreed to indemnify SMS for certain shortfalls in the annual purchase commitments entered into by SMS on behalf of the Popeyes restaurant system. To date, that indemnity has never been called due to the demand for poultry and the chicken suppliers’ ability to mitigate shortfalls, if any. Information about this guarantee can be found in Item 7 of this Annual Report under the caption “Off-Balance Sheet Arrangements.”

 

We have entered into long-term beverage supply arrangements with certain major beverage vendors. These contracts are customary in the QSR industry. Pursuant to the terms of these arrangements, marketing rebates are provided to the owner/operator of Popeyes restaurants based upon the volume of beverage purchases.

 

We also have a long-term agreement with Diversified Foods and Seasonings, Inc. (“Diversified”), under which we have designated Diversified as the supplier of certain proprietary products for the Popeyes system. Diversified sells these products to our approved distributors, who in turn sell them to our franchised and company-operated Popeyes restaurants.

 

Marketing and Advertising

 

We contribute on behalf of our company-operated restaurants, together with our Popeyes franchisees who contribute on behalf of their franchised restaurants, to an advertising fund that supports (1) branding initiatives and the development of marketing materials that are used throughout our domestic restaurant system and (2) local marketing programs. We act as agent for the fund and coordinate its activities. We work closely with franchisees on local marketing programs, which are the principal uses of collected funds. We and our Popeyes franchisees made contributions to the advertising fund of approximately $57.7 million in 2006, $56.3 million in 2005, and $53.7 million in 2004.

 

Fiscal Year and Seasonality

 

Our fiscal year is composed of 13 four-week accounting periods and ends on the last Sunday in December. The first quarter of our fiscal year has four periods, or 16 weeks. All other quarters have three periods, or 12 weeks. Fiscal 2006, which ended on December 31, 2006, included 53 weeks (including one five-week accounting period in our fiscal fourth quarter); fiscal 2005 and fiscal 2004 included 52 weeks.

 

Seasonality has little effect on our operations.

 

Employees

 

As of December 31, 2006, we had 1,532 hourly employees working in our company-operated restaurants. Additionally, we had 82 employees involved in the management of our company-operated restaurants, composed of multi-unit managers and field management employees. We also had 137 employees responsible for corporate administration, franchise administration and business development.

 

None of our employees are covered by a collective bargaining agreement. We believe that the dedication of our employees is critical to our success and that our relationship with our employees is good.

 

Intellectual Property and Other Proprietary Rights

 

We own a number of trademarks and service marks that have been registered with the U.S. Patent and Trademark Office, including the marks “AFC,” “AFC Enterprises,” “Popeyes,” “Popeyes Chicken & Biscuits,” and the brand logo for Popeyes. In addition, we have registered, or made application to register, one or more of these marks and others, or their linguistic equivalents, in foreign countries in which we do business, or are contemplating doing business. There is no assurance that we will be able to obtain the registration for the marks in every country where registration has been sought. We consider our intellectual property rights to be important to our business and we actively defend and enforce them.

 

Copeland Formula Agreement.   We have a formula licensing agreement with Alvin C. Copeland, the founder of Popeyes. Under this agreement, we have the worldwide exclusive rights to the Popeyes fried chicken recipe and certain other ingredients used in Popeyes products. The agreement provides that we pay Mr. Copeland approximately $3.1 million annually through March 2029.

 

King Features Agreements.   We have several agreements with the King Features Syndicate Division (“King Features”) of Hearst Holdings, Inc. under which we have the non-exclusive license to use the image and likeness of the cartoon character “Popeye” in the United States. Popeyes locations outside the United States have the non-exclusive use of the image and likeness of the cartoon character “Popeye” and certain companion characters. We are obligated to pay King Features a royalty of approximately $1.0 million annually, as adjusted for fluctuations in the Consumer Price Index, plus twenty percent of our gross revenues from the sale of products outside of the Popeyes restaurant system, if any. These agreements extend through June 30, 2010.

 

International Operations

 

We continue to expand our international operations through franchising. As of December 31, 2006, we franchised 319 international restaurants. During 2006, franchise revenues from these operations represented approximately 8.8% of our total franchise revenues. For each of 2006, 2005 and 2004, international revenues represented 4.7%, 4.5%, and 4.0% of total revenues, respectively.

 

Insurance

 

We carry property, general liability, business interruption, crime, directors and officers liability, employment practices liability, environmental and workers’ compensation insurance policies, which we believe are customary for businesses of our size and type. Pursuant to the terms of their franchise agreements, our franchisees are also required to maintain certain types and levels of insurance coverage, including commercial general liability insurance, workers’ compensation insurance, all risk property and automobile insurance.

 

Competition

 

The foodservice industry, and particularly the QSR industry, is intensely competitive with respect to price, quality, name recognition, service and location. We compete against other QSRs, including chicken, hamburger, pizza, Mexican and sandwich restaurants, other purveyors of carry out food and convenience dining establishments, including national restaurant chains. Many of our competitors possess substantially greater financial, marketing, personnel and other resources than we do.

 

Government Regulation

 

We are subject to various federal, state and local laws affecting our business, including various health, sanitation, fire and safety standards. Newly constructed or remodeled restaurants are subject to state and local building code and zoning requirements. In connection with the re-imaging and alteration of our company-operated restaurants, we may be required to expend funds to meet certain federal, state and local regulations, including regulations requiring that remodeled or altered restaurants be accessible to persons with disabilities. Difficulties or failures in obtaining the required licenses or approvals could delay or prevent the opening of new restaurants in particular areas.

 

We are also subject to the Fair Labor Standards Act and various other laws governing such matters as minimum wage requirements, overtime and other working conditions and citizenship requirements. A significant number of our foodservice personnel are paid at rates related to the federal minimum wage, and increases in the minimum wage have increased our labor costs.

 

Many states and the Federal Trade Commission, as well as certain foreign countries, require franchisors to transmit specified disclosure statements to potential franchisees before granting a franchise. Additionally, some states and certain foreign countries require us to register our franchise offering documents before we may offer a franchise. We believe that our uniform franchise offering circulars, together with any applicable state versions or supplements, and our franchising procedures, comply in all material respects with both the Federal Trade

Commission guidelines and all applicable state laws regulating franchising in those states which we have offered franchises. We believe that our international disclosure statements, franchise offering documents and franchising procedures comply, in all material respects, with the laws of the foreign countries in which we have offered franchises.

 

Environmental Matters

 

We are subject to various federal, state and local laws regulating the discharge of pollutants into the environment. We believe that we conduct our operations in substantial compliance with applicable environmental laws and regulations. Certain of our current and formerly owned and/or leased properties are known or suspected to have been used by prior owners or operators as retail gas stations and a few of these properties may have been used for other environmentally sensitive purposes. Certain of these properties previously contained underground storage tanks (“USTs”) and some of these properties may currently contain abandoned USTs. It is possible that petroleum products and other contaminants may have been released at these properties into the soil or groundwater. Under applicable federal and state environmental laws, we, as the current or former owner or operator of these sites, may be jointly and severally liable for the costs of investigation and remediation of any such contamination, as well as any other environmental conditions at its properties that are unrelated to USTs. We have obtained insurance coverage that we believe is adequate to cover any potential environmental remediation liabilities. We are currently not subject to any administrative or court order requiring remediation at any of our properties.

 

Where You Can Find Additional Information

 

We file our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports with the Securities and Exchange Commission (the “SEC”). You may obtain copies of these documents by visiting the SEC’s Public Reference Room at 100 F. Street, N.E., Room 1580, Washington, DC 20549, by calling the SEC at 1-800-SEC-0330 or by accessing the SEC’s website at http://www.sec.gov. In addition, as soon as reasonably practicable after such materials are filed with, or furnished to, the SEC, we make copies of these documents (except for exhibits) available to the public free of charge through our web site at www.afce.com or by contacting our Secretary at our principal offices, which are located at 5555 Glenridge Connector, NE, Suite 300, Atlanta, Georgia 30342, telephone number (404) 459-4450.

 

Certain statements we make in this filing, and other written or oral statements made by or on our behalf, may constitute “forward-looking statements” within the meaning of the federal securities laws. Words or phrases such as “should result,” “are expected to,” “we anticipate,” “we estimate,” “we project,” “we believe,” or similar expressions are intended to identify forward-looking statements. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. We believe that these forward-looking statements are reasonable; however, you should not place undue reliance on such statements. Such statements speak only as of the date they are made, and we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of future events, new information or otherwise. The following risk factors, and others that we may add from time to time, are some of the factors that could cause our actual results to differ materially from the expected results described in our forward-looking statements.

 

If we are unable to compete successfully against other companies in the QSR industry or develop new products that appeal to consumer preferences, we could lose customers and our revenues may decline.

 

The QSR industry is intensely competitive with respect to price, quality, brand recognition, service and location. If we are unable to compete successfully against other foodservice providers, we could lose customers and our revenues may decline. We compete against other QSRs, including chicken, hamburger, pizza, Mexican and sandwich restaurants, other purveyors of carry out food and convenience dining establishments, including national restaurant chains. Many of our competitors possess substantially greater financial, marketing, personnel and other resources than we do. There can be no assurance that consumers will continue to regard our products favorably, that we will be able to develop new products that appeal to consumer preferences, or that we will be able to continue to compete successfully in the QSR industry.

 

Because our operating results are closely tied to the success of our franchisees, the failure or loss of one or more of these franchisees could adversely affect our operating results.

 

Our operating results are dependent on our franchisees and, in some cases, on certain franchisees that operate a large number of restaurants. How well our franchisees operate their restaurants and their desire to maintain their franchise relationship with us is outside of our direct control. Any failure of these franchisees to operate their franchises successfully or loss of these franchisees could adversely affect our operating results. As of December 31, 2006, we had 347 franchisees operating restaurants within the Popeyes system and several preparing to become operators. The largest of our domestic franchisees operates 166 Popeyes restaurants; and the largest of our international franchisees operates 108 Popeyes restaurants. Typically, each of our international franchisees is responsible for the development of significantly more restaurants than our domestic franchisees. As a result, our international operations are more closely tied to the success of a smaller number of franchisees than our domestic operations. There can be no assurance that our domestic and international franchisees will operate their franchises successfully.

 

If we face continuing labor shortages or increased labor costs, our growth and operating results could be adversely affected.

 

Labor is a primary component in the cost of operating our restaurants. As of December 31, 2006, we employed 1,532 hourly employees in our company-operated restaurants. If we face labor shortages or increased labor costs because of increased competition for employees, higher employee turnover rates, increases in the federal minimum wage or increases in other employee benefits costs (including costs associated with health insurance coverage), our operating expenses could increase and our growth could be adversely affected. Our success depends in part upon our and our franchisees’ ability to attract, motivate and retain a sufficient number of qualified employees, including restaurant managers, kitchen staff and servers, necessary to keep pace with our expansion schedule. The number of qualified individuals needed to fill these positions is in short supply in some areas.

 

Since Hurricane Katrina, in our New Orleans company market, we have experienced labor shortages and increased labor costs. If this were to continue indefinitely, our future operating results could be adversely impacted.

As it is, increased sales in those same restaurants since the hurricane have more than compensated for the increased costs. However, if sales normalize in future periods, we may have a cost structure out of line with our restaurant sales volume in that market.

 

If the cost of chicken increases, our cost of sales will increase and our operating results could be adversely affected.

 

The principal raw material for Popeyes is fresh chicken. Any material increase in the costs of fresh chicken could adversely affect our operating results. Our company-operated and franchised restaurants purchase fresh chicken from various suppliers who service us from various plant locations. These costs are significantly affected by increases in the cost of chicken, which can result from a number of factors, including increases in the cost of grain, disease, declining market supply of fast-food sized chickens and other factors that affect availability. Because our purchasing agreements for fresh chicken allow the prices that we pay for chicken to fluctuate, a rise in the prices of chicken products could expose us to cost increases. If we fail to anticipate and react to increasing food costs by adjusting our purchasing practices or increasing our sales prices, our cost of sales may increase and our operating results could be adversely affected.

 

Shortages or interruptions in the supply or delivery of fresh food products could adversely affect our operating results.

 

We, and our franchisees, are dependent on frequent deliveries of fresh food products that meet our specifications. Shortages or interruptions in the supply of fresh food products caused by unanticipated demand, problems in production or distribution, declining number of distributors, inclement weather or other conditions could adversely affect the availability, quality and cost of ingredients, which would adversely affect our operating results.

 

Changes in consumer preferences and demographic trends, as well as concerns about health or food safety and quality, could result in a loss of customers and reduce our revenues.

 

Foodservice businesses are often affected by changes in consumer tastes, national, regional and local economic conditions, discretionary spending priorities, demographic trends, traffic patterns and the type, number and location of competing restaurants. Our franchisees, and we, are from time to time, the subject of complaints or litigation from guests alleging illness, injury or other food quality, health or operational concerns. Adverse publicity resulting from these allegations may harm our reputation or our franchisees’ reputation, regardless of whether the allegations are valid or not, whether we are found liable or not, or those concerns relate only to a single restaurant or a limited number of restaurants or many restaurants. In addition, the restaurant industry is currently under heightened legal and legislative scrutiny resulting from the perception that the practices of restaurant companies have contributed to the obesity of their guests. Additionally, some animal rights organizations have engaged in confrontational demonstrations at certain restaurant companies across the country. As a multi-unit restaurant company, we can be adversely affected by the publicity surrounding allegations involving illness, injury, or other food quality, health or operational concerns. Complaints, litigation or adverse publicity experienced by one or more of our franchisees could also adversely affect our business as a whole. If we are unable to adapt to changes in consumer preferences and trends, or we have adverse publicity due to any of these concerns, we may lose customers and our revenues may decline.

 

Instances of avian flu or food-borne illnesses could adversely affect the price and availability of poultry and other foods and create negative publicity which could result in a decline in our sales.

 

Instances of avian flu or food-borne illnesses could adversely affect the price and availability of poultry and other foods. As a result, Popeyes restaurants could experience a significant increase in food costs if there are additional instances of avian flu or food-borne illnesses. In addition to losses associated with higher prices and a lower supply of our food ingredients, instances of food-borne illnesses could result in negative publicity for us. This negative publicity, as well as any other negative publicity concerning food products we serve, may reduce demand for our food and could result in a decrease in guest traffic to our restaurants. A decrease in guest traffic to Popeyes restaurants as a result of these health concerns or negative publicity could result in a decline in our sales.

 

The effect of Hurricane Katrina and any failure to properly address the issues caused by Hurricane Katrina could adversely affect our operating results.

 

During the last week of August 2005, the Company’s business operations in Louisiana, Mississippi, and Alabama were adversely impacted by Hurricane Katrina. We describe the effect of Hurricane Katrina on our operations at Note 16 to our Consolidated Financial Statement. There were 36 company-operated restaurants which were temporarily closed as a result of Hurricane Katrina. At December 31, 2006, 21 of these restaurants had re-opened (1 of which had temporarily closed due to fire damage), 8 had been permanently closed, and 7 remained temporarily closed.

 

Our ability to re-open remaining restaurants impacted by Hurricane Katrina depends on a number of factors, including but not limited to: the restoration of local and regional infrastructure such as utilities, transportation and other public services; the displacement and return of the population in affected locations and the plans of governmental authorities for the rebuilding of affected areas; and the amounts and timing of payments under our insurance coverage. Our ability to collect our insurance coverage is subject to, among other things, our insurers not denying coverage of claims, timing matters related to the processing and payment of claims and the solvency of our insurance carriers. Factors which could limit our ability to recover total losses from insurance proceeds include: the percentage of losses ultimately attributable to wind versus flood perils, the business interruption recovery period deemed allowable under the term of our insurance policies, and our ability to limit ongoing costs such as facility rents, taxes, and utilities.

 

Further, there can be no assurance that sales levels at certain company-operated and franchised restaurants open in the region will continue at the heightened levels experienced since the storm.

 

If any member of our senior management left us, our operating results could be adversely affected, and we may not be able to attract and retain additional qualified management personnel.

 

We are dependent on the experience and industry knowledge of the members of our senior management team. If, for any reason, our senior executives do not continue to be active in management or if we are unable to retain qualified new members of senior management, our operating results could be adversely affected. We cannot guarantee that we will be able to attract and retain additional qualified senior executives as needed. We have employment agreements with certain executives; however, these agreements do not ensure their continued employment with us.

 

As we disclosed on March 2, 2007, Ken Keymer, our current Chief Executive Officer and President has resigned effective March 30, 2007. Our Board of Directors has appointed Fred Beilstein, former Chief Financial Officer of AFC Enterprises, as interim Chief Executive Officer effective March 30, 2007 and has engaged an executive search firm to work with us to find a new Chief Executive Officer. Turnover, particularly among senior management like our Chief Executive Officer, can create distractions as we search for replacement personnel, which could result in recruiting, relocation, training and other costs and can cause operational inefficiencies.

 

Our 2005 Credit Facility may limit our ability to expand our business, and our ability to comply with the covenants, tests and restrictions contained in this agreement may be affected by events that are beyond our control.

 

The 2005 Credit Facility contains financial and other covenants, including covenants requiring us to maintain various financial ratios, limiting our ability to incur additional indebtedness, restricting the amount of capital expenditures that may be incurred, restricting the payment of cash dividends and limiting the amount of debt which can be loaned to our franchisees or guaranteed on their behalf. This facility also limits our ability to engage in mergers or acquisitions, sell certain assets, repurchase our stock and enter into certain lease transactions. The 2005 Credit Facility includes customary events of default, including, but not limited to, the failure to pay any interest, principal or fees when due, the failure to perform certain covenant agreements, inaccurate or false representations or warranties, insolvency or bankruptcy, change of control, the occurrence of certain ERISA events and judgment defaults. The restrictive covenants in our 2005 Credit Facility may limit our ability to expand our business, and our ability to comply with these provisions may be affected by events beyond our control. A failure to comply with any of the financial and operating covenants included in the 2005 Credit Facility would result in an event of default,

permitting the lenders to accelerate the maturity of outstanding indebtedness. This acceleration could also result in the acceleration of other indebtedness that we may have outstanding at that time. Were we to default on the terms and conditions of the 2005 Credit Facility and the debt were accelerated by the facility’s lenders, such developments would have a material adverse impact on our financial condition and our liquidity.

 

If our franchisees are unable or unwilling to open a sufficient number of restaurants, our growth strategy could be at risk.

 

As of December 31, 2006, we franchised 1,503 restaurants domestically and 319 restaurants in Puerto Rico, Guam and 24 foreign countries. Our growth strategy is significantly dependent on increasing the number of our franchised restaurants. If our franchisees are unable to open a sufficient number of restaurants, our growth strategy could be significantly impaired.

 

Our ability to successfully open additional franchised restaurants will depend on various factors, including the availability of suitable sites, the negotiation of acceptable leases or purchase terms for new locations, permitting and regulatory compliance, the ability to meet construction schedules, the financial and other capabilities of our franchisees, and general economic and business conditions. Many of the foregoing factors are beyond the control of our franchisees. Further, there can be no assurance that our franchisees will successfully develop or operate their restaurants in a manner consistent with our concepts and standards, or will have the business abilities or access to financial resources necessary to open the restaurants required by their agreements. Historically, there have been many instances in which Popeyes franchisees have not fulfilled their obligations under their development agreements to open new restaurants.

 

Currency, economic, political and other risks associated with our international operations could adversely affect our operating results.

 

As of December 31, 2006, we had 319 franchised restaurants in Puerto Rico, Guam and 24 foreign countries. Business at these operations is conducted in the respective local currency. The amount owed us is based on a conversion of the royalties and other fees to U.S. dollars using the prevailing exchange rate. In particular, the royalties are based on a percentage of net sales generated by our foreign franchisees’ operations. Consequently, our revenues from international franchisees are exposed to the potentially adverse effects of our franchisees’ operations, currency exchange rates, local economic conditions, political instability and other risks associated with doing business in foreign countries. We expect that our franchise revenues generated from international operations will increase in the future, thus increasing our exposure to changes in foreign economic conditions and currency fluctuations.

 

We have recently experienced a decline in the number of restaurants we have franchised in Korea.

 

We had 116 franchised restaurants in Korea as of December 31, 2006 as compared to 154 at December 25, 2005. The decline in the number of Korean restaurants was primarily due to weak financial and operating performance by our master franchisee in that country (our largest international franchisee). We agreed to abate the entire 3% royalty due to be paid to us by that franchisee for the last two quarters of 2005 and to abate one-third of the royalties to be paid to us during the first two quarters of 2006. We continue to work with that franchisee to address challenges facing its restaurants and those of sub-franchisees concerning sales growth and profitability, and to otherwise strengthen our franchise system in that country. There can be no assurance; however, that these efforts will be successful.

 

If we and our franchisees fail to purchase chicken at quantities specified in SMS’s poultry contracts, we may have to purchase the commitment short-fall and this could adversely affect our operating results.

 

In order to ensure favorable pricing for fresh chicken purchases and to maintain an adequate supply of fresh chicken for us and our Popeyes franchisees, SMS has entered into poultry supply contracts with various suppliers. These contracts establish pricing arrangements, as well as purchase commitments. AFC has agreed to indemnify SMS as it concerns any shortfall of annual purchase commitments entered into by SMS on behalf of the Popeyes restaurant system. If we and our Popeyes franchisees fail to purchase fresh chicken at the commitment levels, and

our suppliers are unable to mitigate damages, AFC may be required to purchase the commitment short-fall. This may result in losses as AFC would then need to find uses for the excess chicken purchases or to resell the excess purchases at spot market prices. This could adversely affect our operating results.

 

Our quarterly results and same-store sales may fluctuate significantly and could fall below the expectations of securities analysts and investors, which could cause the market price of our common stock to decline.

 

Our quarterly operating results and same-store sales have fluctuated significantly in the past and may continue to fluctuate significantly in the future as a result of a variety of factors, many of which are outside of our control. If our quarterly results or same-store sales fluctuate or fall below the expectations of securities analysts and investors, the market price of our common stock could decline.

 

Factors that may cause our quarterly results or same-store sales to fluctuate include the following:

 

 

Accordingly, results for any one-quarter are not indicative of the results to be expected for any other quarter or for the full year, and same-store sales for any future period may decrease.

 

We are subject to government regulation, and our failure to comply with existing regulations or increased regulations could adversely affect our business and operating results.

 

We are subject to numerous federal, state, local and foreign government laws and regulations, including those relating to:

 

 

If we fail to comply with existing or future regulations, we may be subject to governmental or judicial fines or sanctions, or we could suffer business interruption or loss. In addition, our capital expenses could increase due to remediation measures that may be required if we are found to be noncompliant with any of these laws or regulations.

 

We are also subject to regulation by the Federal Trade Commission and to state and foreign laws that govern the offer, sale and termination of franchises and the refusal to renew franchises. The failure to comply with these regulations in any jurisdiction or to obtain required approvals could result in a ban or temporary suspension on future franchise sales or fines or require us to make a rescission offer to franchisees, any of which could adversely affect our business and operating results.

 

The SEC investigation arising in connection with the restatement of our financial statements could adversely affect our financial condition.

 

On April 30, 2003, we received an informal, nonpublic inquiry from the staff of the SEC requesting voluntary production of documents and other information. The requests, for documents and information, to which we have responded, relate primarily to our announcement on March 24, 2003 indicating we would restate our financial statements for fiscal year 2001 and the first three quarters of 2002. The staff has informed our counsel that the SEC issued an order authorizing a formal investigation with respect to these matters. We have cooperated with the SEC in these inquiries.

 

We may not be able to adequately protect our intellectual property, which could harm the value of our Popeyes brand and branded products and adversely affect our business.

 

We depend in large part on our Popeyes brand and branded products and believe that it is very important to the conduct of our business. We rely on a combination of trademarks, copyrights, service marks, trade secrets and similar intellectual property rights to protect our Popeyes brand and branded products. The success of our expansion strategy depends on our continued ability to use our existing trademarks and service marks in order to increase brand awareness and further develop our branded products in both domestic and international markets. We also use our trademarks and other intellectual property on the Internet. If our efforts to protect our intellectual property are not adequate, or if any third party misappropriates or infringes on our intellectual property, either in print or on the internet, the value of our Popeyes brand may be harmed, which could have a material adverse effect on our business, including the failure of our Popeyes brand and branded products to achieve and maintain market acceptance.

 

We franchise our restaurants to various franchisees. While we try to ensure that the quality of our Popeyes brand and branded products is maintained by all of our franchisees, we cannot be certain that these franchisees will not take actions that adversely affect the value of our intellectual property or reputation.

 

We have registered certain trademarks and have other trademark registrations pending in the U.S. and foreign jurisdictions. The trademarks that we currently use have not been registered in all of the countries in which we do business and may never be registered in all of these countries. We cannot be certain that we will be able to adequately protect our trademarks or that our use of these trademarks will not result in liability for trademark infringement, trademark dilution or unfair competition.

 

There can be no assurance that all of the steps we have taken to protect our intellectual property in the U.S. and foreign countries will be adequate. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the U.S. Further, through acquisitions of third parties, we may acquire brands and related trademarks that are subject to the same risks as the brand and trademarks we currently own.

 

Because certain of our current or former properties were used as retail gas stations in the past, we may incur substantial liabilities for remediation of environmental contamination at our properties.

 

Certain of our currently or formerly owned and/or leased properties (including certain Church’s locations formerly owned) are known or suspected to have been used by prior owners or operators as retail gas stations, and a few of these properties may have been used for other environmentally sensitive purposes. Certain of these properties previously contained underground storage tanks, and some of these properties may currently contain abandoned underground storage tanks. It is possible that petroleum products and other contaminants may have been released at these properties into the soil or groundwater. Under applicable federal and state environmental laws, we, as the current or former owner or operator of these sites, may be jointly and severally liable for the costs of investigation and remediation of any contamination, as well as any other environmental conditions at our properties that are unrelated to underground storage tanks. If we are found liable for the costs of remediation of contamination at any of these properties, our operating expenses would likely increase and our operating results would be materially adversely affected. We have obtained insurance coverage that we believe will be adequate to cover any potential environmental remediation liabilities. However, there can be no assurance that the actual costs of any potential remediation liabilities will not materially exceed the amount of our policy limits.

 

None.

 

We either own, lease or sublease the land and buildings for our company-operated restaurants. In addition, we own, lease or sublease land and buildings, which we lease or sublease to our franchisees and third parties.

 

The following table sets forth the locations by state of our domestic company-operated restaurants as of December 31, 2006:

 

 

At December 31, 2006, seven company-operated restaurants remained temporarily closed due to the adverse effects of Hurricane Katrina and one company-operated restaurant was temporarily closed due to fire damage. These temporarily closed restaurants are excluded from the above table. A second company-operated restaurant temporarily closed subsequent to December 31, 2006 due also to fire damage.

 

We typically lease our restaurants under “triple net” leases that require us to pay minimum rent, real estate taxes, maintenance costs and insurance premiums and, in some cases, percentage rent based on sales in excess of specified amounts. Generally, our leases have initial terms ranging from five to 20 years, with options to renew for one or more additional periods, although the terms of our leases vary depending on the facility.

 

Within our franchise operations segment, our typical restaurant leases or subleases to franchisees are triple net to the franchisee, that require them to pay minimum rent (based upon prevailing market rental rates), real estate taxes, maintenance costs and insurance premiums, as well as percentage rents based on sales in excess of specified amounts. These leases have a term that usually coincides with the term of the underlying base lease for the location. These leases are typically cross-defaulted with the corresponding franchise agreement for that site. At December 31, 2006, we leased or subleased 71 restaurants to franchisees, of which 24 were owned by us.

 

At December 31, 2006, we leased approximately 30,000 square feet of office space in a facility located in Atlanta, Georgia that is the headquarters for the Company. This lease is subject to extensions through 2016.

 

We believe that our leased and owned facilities provide sufficient space to support our corporate and operational needs.

 

We were previously involved in several lawsuits arising from our announcements on March 24, 2003 and April 22, 2003 indicating that we would restate certain previously issued financial statements, including a derivative lawsuit filed by plaintiffs claiming to be acting on behalf of AFC and certain Section 10(b) and Section 11 securities litigation. During the second quarter of 2005, we settled these lawsuits pursuant to joint settlement agreements (the “Joint Settlement Agreements”) and recognized $21.8 million of charges related to shareholder litigation, including $15.5 million associated with the joint settlement agreements.

 

On April 30, 2003, we received an informal, nonpublic inquiry from the staff of the SEC requesting voluntary production of documents and other information. The requests, for documents and information, to which we have responded, relate primarily to our announcement on March 24, 2003 indicating we would restate our financial statements for fiscal year 2001 and the first three quarters of 2002. The staff has informed our counsel that the SEC has issued an order authorizing a formal investigation with respect to these matters. We have cooperated with the SEC in these inquiries.

 

We are involved in legal matters against certain of our former insurers related to directors and officers liability insurance policies, constituting a gain contingency. We are unable to predict the outcome of these matters. If we were successful in these matters, a substantial portion of any recovery would be provided to (1) the counterparties to the above referenced Joint Settlement Agreements, and (2) our attorneys in these matters.

 

We are a defendant in various legal proceedings arising in the ordinary course of business, including claims resulting from “slip and fall” accidents, employment-related claims, claims from guests or employees alleging illness, injury or other food quality, health or operational concerns and claims related to franchise matters. We have established adequate reserves to provide for the defense and settlement of such matters, and we believe their ultimate resolution will not have a material adverse effect on our financial condition or our results of operations.

 

Not applicable.

 

The following table sets forth the name, age (as of the date of this filing) and position of our current executive officers:

 

 

Kenneth L. Keymer, age 58, has served as our Chief Executive Officer since September 2005 and as President of Popeyes ^® Chicken & Biscuits since June 2004. From January 2002 to May 2004, Mr. Keymer served as President and Co-chief Executive Officer and Member of the Board of Directors of Noodles  & Company, which is based in Boulder, Colorado. From August 1996 to January 2002, Mr. Keymer was President and Chief Operating Officer of Sonic Corporation, the largest publicly-held chain of drive-in restaurants in the U.S. While at Sonic, he led the management team, oversaw franchising operations, company operations, promotional and field marketing, as well as R&D, information technology, and construction, and served as a member of the Board of Directors.

 

On March 2, 2007, the Company announced the resignation of Mr. Keymer effective March 30, 2007. The Company’s Board of Directors has appointed Fred Beilstein, Former Chief Financial Officer of AFC Enterprises, as interim Chief Executive Officer effective March 30, 2007 and has engaged an executive search firm to work with the Company to find a new Chief Executive Officer.

 

H. Melville Hope, III, age 45, has served as our Chief Financial Officer since December 2005. From February 2004 until December 2005, Mr. Hope served as our Senior Vice President, Finance and Chief Accounting Officer. From April 2003 to February 2004, Mr. Hope was our Vice President of Finance. Prior to joining AFC, he was an independent consultant in Atlanta, Georgia from January 2003 to April 2003. From April 2002 to January 2003, Mr. Hope was Chief Financial Officer for First Cambridge HCI Acquisitions, LLC, a real estate investment firm, located in Birmingham, Alabama. From November 2001 to April 2002, Mr. Hope was a financial and business advisory consultant in Atlanta, Georgia. From July 1984 to July 2001, Mr. Hope was an accounting, auditing and business advisory professional for PricewaterhouseCoopers, LLP in Atlanta, Georgia, in Savannah, Georgia and in Houston, Texas where he was admitted to the partnership in 1998.

 

James W. Lyons, age 52, was appointed to the position of our Chief Operating Officer effective March 2, 2007. Prior to that, Mr. Lyons had served as our Chief Development Officer since July 2004. From June 2002 to April 2004, he was Vice President of Development for Domino’s Pizza in Ann Arbor, Michigan. Mr. Lyons was Executive Vice President of Franchising and Development for Denny’s Restaurants in Spartanburg, South Carolina from July 1997 to December 2001.

 

Robert Calderin, age 49, has served as our Chief Marketing Officer since January 2005. From September 2001 to December 2004, he was an owner of Novus Mentis, Inc. in Miami, Florida. Mr. Calderin was Vice President, U.S. Marketing for Burger King Corporation in Miami, Florida from February 1998 to September 2001.

 

Harold M. Cohen, age 43, has served as our Senior Vice President of Legal Affairs, Corporate Secretary and General Counsel since September 2005. Mr. Cohen has been General Counsel of Popeyes Chicken & Biscuits, a division of AFC Enterprises, Inc., since January 2005. He also has served as Vice President of AFC since July 2000. From April 2001 to December 2004, he served as Deputy General Counsel of AFC. From August 1995 to June 2000, he was Corporate Counsel for AFC.

 

Our common stock currently trades on the Nasdaq Global Market under the symbol “AFCE.”

 

The following table sets forth the high and low per share sales prices of our common stock, by quarter, for fiscal years 2006 and 2005.

 

 

 

 

Shareholders of Record

 

As of February 25, 2007, we had 105 shareholders of record of our common stock.

Dividend Policy

 

On May 11, 2005, our Board of Directors declared a special cash dividend of $12.00 per common share. The dividend, which totaled $352.9 million, was paid on June 3, 2005 to the common shareholders of record at the close of business on May 23, 2005. We funded the dividend with a portion of the net proceeds from the sale of Church’s and a portion of the net proceeds from our 2005 Credit Facility.

 

We anticipate that we will retain any future earnings to support operations and to finance the growth and development of our business, and we do not expect to pay cash dividends in the foreseeable future. Any future determination relating to our dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions, plans for share repurchases, future prospects and other factors that the board of directors may deem relevant. Other than the special cash dividend, we have never declared or paid cash dividends on our common stock. Additionally, our 2005 Credit Facility restricts the extent to which we may declare or pay a cash dividend.

 

Our Peer Group Index is now composed of the following quick service restaurant companies: CKE Restaurants, Inc., Jack In the Box, Inc., Papa Johns International Inc., Sonic Corp., Yum! Brands Inc., and Wendy’s International Inc.

 

The following data was derived from our Consolidated Financial Statements. Such data should be read in conjunction with our Consolidated Financial Statements and the notes thereto and our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” at Item 7 of this Annual Report.

 

 

 

(1)  Factors that impact the comparability of revenues for the years presented include:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The following discussion and analysis should be read in conjunction with our Selected Financial Data and our Consolidated Financial Statements that are included elsewhere in this filing.

 

Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements, as a result of a number of factors including those factors set forth in Item 1A. of this Annual Report and other factors presented throughout this filing.

 

Nature of Business

 

AFC develops, operates, and franchises quick-service restaurants under the trade name Popeyes ^® Chicken & Biscuits (“Popeyes”) in 44 states, the District of Columbia, Puerto Rico, Guam, and 24 foreign countries. Popeyes has two reportable business segments: franchise operations and company-operated restaurants. Financial information concerning these business segments can be found at Note 24 to our Consolidated Financial Statements.

 

Historically, AFC also developed, operated and franchised quick-service restaurants and bakeries under the trade names Church’s Chicken ^® (“Church’s”) (sold December 28, 2004), Cinnabon ^® (“Cinnabon”) (sold November 4, 2004) and Seattle’s Best Coffee ^® (“Seattle Coffee”) (sold July 14, 2003). For a discussion of these divestitures, see Note 22 to our Consolidated Financial Statements. In our Consolidated Financial Statements, financial results relating to these divested operations are presented as discontinued operations. Unless otherwise noted, discussions and amounts throughout this Annual Report relate to our continuing operations.

 

Management Overview of 2006 Operating Results

 

During 2006, our accomplishments include the following. We:

 

 

2006 Same-Store Sales

 

During 2006, total domestic same-store sales increased 1.6%. By business segment, domestic same-store sales improved 1.3% for our domestic franchised restaurants and 9.0% for our company-operated restaurants.

 

Our total domestic same-store sales growth, while positive for fiscal year 2006, declined during the latter part of the third quarter and during the fourth quarter due primarily to the continuing effect of economic concerns related to the discretionary income of our consumers and the impact of rolling over strong comparable sales in markets affected by Hurricanes Katrina and Rita in 2005. During 2005, the hurricanes displaced residents from the costal region into surrounding markets in Louisiana, Texas and Mississippi. As a result, these surrounding markets, which represent approximately 20% of our total domestic system, realized strong same-store sales growth during the latter part of the third quarter and throughout the fourth quarter of 2005. Additionally, restaurants forced to close due to the hurricanes realized extraordinarily high sales performance upon re-opening as workers and residents returned.

The total same-store sales growth of 9% for our company-operated business segment was driven principally by our New Orleans market, which comprised over 35% of our company-operated restaurants as of December 31, 2006. Our company-operated restaurants benefited during the first three quarters of 2006 from the return of residents, influx of consumers engaged in rebuilding New Orleans and reduced QSR competition in that market following Hurricane Katrina in August of 2005. Restaurants that re-opened continued to experience elevated sales levels during the first three quarters of 2006 as compared to the comparable periods of 2005. However, our company-operated restaurants realized negative same-store sales growth in the fourth quarter of 2006 due to the impact of rolling over the extraordinarily high sales performance in the New Orleans market for stores re-opened during 2005, as compared to the somewhat normalized sales levels during the comparable periods of 2006.

 

Within our international operations, our same-store sales decreased by 3.2% during fiscal 2006. However, international same-store sales performance demonstrated improvement during the latter part of 2006 as strong performance in Latin America and the Middle East helped offset negative performance in Korea and on U.S. military bases abroad. Although remaining negative, Korea has shown steady progress as operational initiatives focused on improving customer experience gain traction.

 

2006 Unit Growth

 

During 2006, our global restaurant system grew by 50 restaurants. We opened 139 new franchised restaurants and 3 new company-operated restaurants. These openings during 2006 were offset by 96 permanent closures (including the closing of 45 franchised restaurants within Korea). In addition, our year end restaurant count includes 4 re-opened restaurants (net of temporary closures) which had been temporarily closed at the end of 2005.

 

As it concerns our expected financial and operating results for 2007, see the discussion under the heading “Operating and Financial Outlook for 2007” later in this Item 7.

 

Factors Affecting Comparability of Consolidated Results of Operations: 2006, 2005, and 2004

 

For 2006, 2005 and 2004, the following items and events affect comparability of reported operating results:

 

 

 

The following table presents selected revenues and expenses as a percentage of total revenues (or, in certain circumstances, as a percentage of a corresponding revenue line item).

 

 

 

Comparisons of Fiscal Years 2006 and 2005

 

Sales by Company-Operated Restaurants

 

Sales by company-operated restaurants were $65.2 million in 2006, a $4.9 million increase from 2005. The increase was primarily due to:

 

 

partially offset by:

 

 

The remaining fluctuation was due to various factors, including restaurant openings, restaurant transfers, and the timing and duration of temporary restaurant closings, in both 2006 and 2005.

 

Franchise Revenues

 

Franchise revenues has three basic components: (1) ongoing royalty payments that are determined based on a percentage of franchisee sales; (2) franchise fees associated with new restaurant openings; and (3) development fees associated with the opening of new franchised restaurants in a given market. Royalty revenues are the largest component of franchise revenues, constituting more than 90% of franchise revenues.

 

Franchise revenues were $82.6 million in 2006, a $5.1 million increase from 2005. Of this increase, approximately $4.2 million was due to an increase in domestic franchise revenues and approximately $0.9 million was due to an increase in international franchise revenues.

 

The $4.2 million increase in domestic franchise revenue was primarily due to: (1) a $3.1 million increase in royalties and fees due principally to a net increase of 52 domestic restaurants from December 25, 2005 to December 31, 2006 and a 1.3% increase in same-store sales, and (2) an increase of approximately $1.2 million in royalties associated with the 53rd week in fiscal year 2006. Fiscal year 2005 consisted of 52 weeks.

 

The $0.9 million increase in international revenue was primarily due to:

 

 

partially offset by:

 

 

Other Revenues

 

Other revenues were $5.2 million in 2006, a $0.4 million decrease from 2005, primarily as a result of a reduction in the number of leased or subleased properties.

 

Restaurant Employee, Occupancy and Other Expenses

 

Restaurant employee, occupancy and other expenses were $33.7 million in 2006, a $3.2 million increase from 2005. The increase was principally attributable to the increase in sales from company-operated restaurants (discussed above). Restaurant employee, occupancy and other expenses were approximately 52% and 51% of sales from company-operated restaurants in 2006 and 2005, respectively.

 

Restaurant Food, Beverages and Packaging

 

Restaurant food, beverages and packaging expenses were $21.3 million in 2006, a $0.7 million increase from 2005. The increase was principally attributable to the increase in sales from company-operated restaurants (discussed above). Restaurant food, beverages and packaging expenses were approximately 33% and 34% of sales from company-operated restaurants in 2006 and 2005, respectively.

 

General and Administrative Expenses

 

General and administrative expenses were $48.1 million in 2006, a $20.6 million decrease from 2005. The decrease was primarily due to:

 

 

partially offset by:

 

 

General and administrative expenses were approximately 31% of total revenues in 2006, compared to approximately 48% in 2005.

 

Depreciation and Amortization

 

Depreciation and amortization was $6.4 million in 2006, a $0.9 million decrease from 2005. The decrease was primarily due to the accelerated depreciation during 2005 associated with the closing of the corporate center. Depreciation and amortization was approximately 4% of total revenues in 2006, compared to 5% in 2005.

 

Other Expenses (Income), Net

 

Other expenses (income), net includes (1) costs associated with certain shareholder litigation discussed in Note 15 to our Consolidated Financial Statements; (2) asset write-downs; (3) hurricane-related costs (other than impairments); (4) estimated insurance proceeds for hurricane-related damages; (5) costs associated with restaurant closures and refurbishments; and (6) gains and losses on the sale of assets.

 

These aggregated to $1.8 million in income in 2006 compared to $23.2 million of expense in 2005. The decrease in expense was primarily due to:

 

 

partially offset by:

 

 

See Note 17 to our Consolidated Financial Statements for a description of other expenses (income), net for 2006, 2005 and 2004.

 

 

Our franchise operations include an allocation of direct and indirect overhead charges incurred by our corporate operations of $29.6 million in 2006, and $24.9 million in 2005. Our company-operated restaurants include an allocation of direct and indirect overhead charges incurred by our corporate operations of $3.8 million in 2006, and $2.8 million in 2005.

 

The $2.2 million favorable fluctuation in operating profit associated with our franchise operations was principally due to higher franchise revenues partially offset by higher corporate allocations primarily for field training activities, marketing activities and IT related costs.

 

The $3.2 million favorable fluctuation in operating profit (loss) associated with our company-operated restaurants was principally due to (1) more company-operated restaurants (both related to re-openings in New Orleans and the acquisition of 13 restaurants in the Memphis and Nashville markets from a franchisee) contributing to our net operating performance, (2) a reduction in damages and costs from Hurricane Katrina in excess of accrued insurance proceeds as compared to fiscal 2005 and (3) gain on sale of assets; partially offset by (4) higher depreciation and amortization, insurance and other costs.

 

The $46.8 million favorable fluctuation in operating profit (loss) associated with our corporate headquarters was principally due to substantially lower general and administrative expenses and lower shareholder litigation and other costs as compared to fiscal 2005.

 

Interest Expense, Net

 

Interest expense, net was $11.1 million in 2006, a $4.3 million increase from 2005. The increase was primarily due to:

 

 

partially offset by:

 

 

Income Tax Expense

 

In 2006, we had an income tax expense associated with our continuing operations of $12.0 million compared to a benefit of $5.3 million in 2005. Our effective tax rate for 2006 was 35.1% compared to 38.7% for 2005 (see a reconciliation of these effective rates in Note 19 to our Consolidated Financial Statements). Our effective tax rate decreased in 2006 compared to 2005 primarily due to provision to return adjustments, partially offset by adjustments to prior year tax accruals, increases in state income taxes and the effects of tax free interest income.

 

Discontinued Operations, Net of Income Taxes

 

Discontinued operations, net of income taxes provided $0.2 million of income in 2006, compared to income of $158.0 million in 2005.

 

During 2005, we sold our Church’s division. We recognized an after-tax gain of $158.0 million.

 

Comparisons of Fiscal Years 2005 and 2004

 

Sales by Company-Operated Restaurants

 

Sales by company-operated restaurants were $60.3 million in 2005, a $25.5 million decrease from 2004. The decrease was primarily due to:

 

 

partially offset by:

 

 

The remaining fluctuation was due to various factors, including the timing and duration of temporary restaurant closings, in both 2005 and 2004, related to the re-imaging or rebuilding of older restaurants.

 

Franchise Revenues

 

Franchise revenues were $77.5 million in 2005, a $4.7 million increase from 2004. The increase was primarily due to a $4.0 million increase in royalties, due principally to an increase in same-store sales, and a $0.7 million increase in franchise fees (net of franchising incentives).

 

Within the international portion of our franchise operations, we experienced a $0.4 million decline in royalties, driven principally by declines in revenues from our Korean franchise operations. This is due to the net closure of 32 franchised restaurants in that country and temporary royalty relief provided our Korean master franchisee, partially offset by growth in the number of franchised restaurants elsewhere in our international system. We agreed to abate the entire 3% royalty due to be paid to us by the Korean master franchisee for the last two quarters of 2005 and to abate one-third of the royalties to be paid to us during the first two quarters of 2006.

 

Other Revenues

 

Other revenues were $5.6 million in 2005, a $0.3 million increase from 2004. The increase is principally due to an increase in rental revenues associated with an increase in the number of restaurants leased to franchisees as a result of unit conversions in 2004.

 

Restaurant Employee, Occupancy and Other Expenses

 

Restaurant employee, occupancy and other expenses were $30.5 million in 2005, a $14.8 million decrease from 2004. The decrease was principally attributable to the decrease in sales from company-operated restaurants (discussed above). Restaurant employee, occupancy and other expenses were approximately 51% and 53% of sales from company-operated restaurants in 2005 and 2004, respectively.

 

Restaurant Food, Beverages and Packaging

 

Restaurant food, beverages and packaging expenses were $20.6 million in 2005, an $8.2 million decrease from 2004. The decrease was principally attributable to the decrease in sales from company-operated restaurants (discussed above). Restaurant food, beverages and packaging expenses were approximately 34% of sales from company-operated restaurants in both 2005 and 2004.

 

General and Administrative Expenses

 

General and administrative expenses were $68.7 million in 2005, a $13.4 million decrease from 2004. The decrease was primarily due to:

 

 

partially offset by:

 

 

General and administrative expenses were approximately 48% of total revenues in 2005, compared to approximately 50% in 2004.

 

Depreciation and Amortization

 

Depreciation and amortization was $7.3 million in 2005, a $2.7 million decrease from 2004. The decrease was primarily due to the write-off of assets in 2004 associated with our corporate operations. Depreciation and amortization was approximately 5% of total revenues in 2005, compared to 6% in 2004.

 

Other Expenses (Income), Net

 

Other expenses (income), net includes (1) costs associated with certain shareholder litigation discussed in Note 15 to our Consolidated Financial Statements; (2) asset write-downs; (3) hurricane-related costs (other than

impairments); (4) estimated insurance proceeds for hurricane-related damages; (5) costs associated with restaurant closures and refurbishments; (6) gains and losses on the sale of assets; and (7) costs associated with the termination of our corporate lease. These aggregated to $23.2 million in 2005, a $6.1 million increase from 2004. The increase was primarily due to:

 

 

partially offset by:

 

 

See Note 17 to our Consolidated Financial Statements for a description of other expenses (income), net for 2006, 2005 and 2004.

 

 

Our franchise operations include an allocation of direct and indirect overhead charges incurred by our corporate operations of $24.9 million in 2005, and $22.2 million in 2004. Our company-operated restaurants include an allocation of direct and indirect overhead charges incurred by our corporate operations of $2.8 million in 2005, and $3.0 million in 2004.

 

The $1.3 million unfavorable fluctuation in operating profit associated with our franchise operations was principally due to higher corporate allocations primarily for new business development activities, partially offset by higher franchise revenues.

 

The $1.8 million unfavorable fluctuation in operating loss associated with our company-operated restaurants was principally due to (1) fewer company-operated restaurants contributing to our net operating performance and (2) damages and costs from Hurricane Katrina in excess of accrued insurance proceeds; partially offset by (3) lower asset impairments exclusive of those resulting from Hurricane Katrina.

 

The $15.6 million favorable fluctuation in operating losses associated with our corporate headquarters was principally due to substantially lower general and administrative expenses and lower lease termination costs associated with the closure of our AFC corporate offices, partially offset by higher shareholder litigation costs.

 

Interest Expense, Net

 

Interest expense, net was $6.8 million in 2005, a $1.3 million increase from 2004. The increase was primarily due to:

 

 

partially offset by:

 

 

During 2005, our outstanding indebtedness associated with continuing operations increased from $92.4 million at the start of fiscal 2005, to $191.4 million at the end of fiscal 2005. During 2005, subsequent to the sale of Church’s, the Company had substantial short-term investments which yielded higher interest income.

 

Income Tax Expense

 

In 2005, we had an income tax benefit associated with our continuing operations of $5.3 million compared to a benefit of $10.7 million in 2004. Our effective tax rate for 2005 was 38.7% compared to 43.0% for 2004 (see a reconciliation of these effective rates in Note 20 to our Consolidated Financial Statements). Our effective tax rate decreased in 2005 compared to 2004 primarily due to adjustments to our valuation allowance for deferred tax assets and adjustments to prior year tax accruals, partially offset by increases in state income taxes and the effects of tax free interest income.

 

Discontinued Operations, Net of Income Taxes

 

Discontinued operations, net of income taxes provided $158.0 million of income in 2005, compared to income of $39.1 million in 2004.

 

During 2005, we sold our Church’s division. We recognized an after-tax gain of $158.0 million.

 

During 2004, we sold our Cinnabon subsidiary. We recognized an after-tax gain of $20.9 million. That gain includes a $22.6 million tax benefit for capital loss carryforwards that arose in connection with our sale of Cinnabon. During 2004, we also recognized an after-tax loss of $0.5 million relating to certain adjustments to the sales price of Seattle Coffee. From an operational perspective, during 2004, we recognized: (1) a net loss of $6.4 million relating to Cinnabon; and (2) net income of $25.1 million relating to Church’s.

 

Cumulative Effect of an Accounting Change, Net of Income Taxes

 

In 2004, we adopted Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 , as revised in December 2003 (“FIN 46R”). In conjunction with its adoption of FIN 46R, the Company recorded a cumulative effect adjustment that decreased net income in 2004 by $0.5 million (of which $0.2 million, after tax, relates to continuing operations). For a discussion of this accounting standard and our adoption of it, see Note 2 to our Consolidated Financial Statements.

Liquidity and Capital Resources

 

We finance our business activities primarily with:

 

 

Based upon our current level of operations, our existing cash reserves ($6.7 million available as of December 31, 2006), and available borrowings under our 2005 Credit Facility, we believe that we will have adequate cash flow to meet our anticipated future requirements for working capital, including various contractual obligations and expected capital expenditures for 2007.

 

Our strong financial position allows us to pursue our growth strategies. Our priorities in the use of available cash are:

 

 

Our investment in core business activities includes the re-imaging of our company-operated restaurants, building of new company-operated restaurants, strategic acquisitions of franchised restaurants, marketing initiatives, and franchisee support systems.

 

In addition to the scheduled payments of principal on the term loan, at the end of each fiscal year the Company is subject to mandatory prepayments (25% or 50% of consolidated excess cash flows as applicable) in those situations when consolidated excess cash flows for the year and total leverage ratio, as defined in the 2005 Credit Facility, exceed specified amounts. During 2006, we paid principal in the amount of $59.5 million, including $57.5 million of voluntary prepayments. Due to the amount of principal paid during the year, the Company has no mandatory payment due on behalf of fiscal 2006 under the terms of the 2005 Credit Facility.

 

During fiscal year 2006, the Company repurchased and retired approximately 1.5 million shares of common stock for approximately $20.3 million. From January 1, 2007 through February 25, 2007 (the end of the Company’s second period for 2007), the Company repurchased and retired an additional 136,400 shares of common stock for approximately $2.4 million. As of February 25, 2007, the remaining value of shares that may be repurchased under the Company’s share repurchase program was $44.8 million. Pursuant to the terms of the Company’s 2005 Credit Facility, the Company is subject to a repurchase limit of approximately $7.3 million for the remainder of fiscal 2007.

 

Operating and Financial Outlook for 2007

 

Fiscal 2007 will consist of 52 weeks as compared to 53 weeks in 2006. For 2007, we estimate full-year total domestic same-store sales growth (blended growth including both company-operated and franchised restaurants) to be between 1.5% to 2.5%. In the first quarter, same-store sales growth is expected to be negative and is expected to strengthen throughout the year, as the rollover effect of hurricane markets diminishes and the Company’s new products, operational improvement efforts and promotional strategies continue to gain traction.

 

During 2007, we expect 165 to 175 new restaurant openings, including 4 to 6 new company-operated restaurants. We estimate that approximately 60% of these openings will be in our domestic system. During 2007, we also expect 70 to 80 permanent restaurant closings, including 30 to 40 closures in Korea.

 

There were 36 company-operated restaurants which were temporarily closed as a result of Hurricane Katrina. At December 31, 2006, 21 of these restaurants had re-opened (1 of which had temporarily closed due to fire damage), 8 had been permanently closed and 7 remained temporarily closed. The Company expects to re-open 2 to 3 additional restaurants in 2007. The remaining company-operated restaurants will be evaluated to determine which restaurants will be re-opened at their current site, relocated, or permanently closed. That evaluation will be significantly influenced by governmental plans for revitalization and re-settlement of New Orleans, which will become clearer over time.

 

We had 116 franchised restaurants in Korea as of December 31, 2006 as compared to 154 at December 25, 2005. The decline in the number of Korean restaurants was primarily due to weak financial and operating performance by our master franchisee in that country. We continue to work with that franchisee to address challenges facing its restaurants and those of sub-franchisees concerning sales growth and profitability, and to otherwise strengthen our franchise system in that country. We expect in 2007 to see moderating comparable sales and restaurant closing trends as well as a resumption of new unit openings.

 

The Company’s general and administrative expenses in fiscal 2007 are expected to be in the range of $48 to $50 million (approximately 2.7% of estimated system-wide sales), an increase over fiscal 2006 due to additional strategic investments in marketing for national cable advertising, and additional field support to be used for accelerating domestic restaurant development, and improving operations and training.

 

Under the heading “Overall Business Strategy” in Item 1 of this Annual Report, we discuss our key operational strategies for fiscal year 2007.

 

Under the heading “Risks Factors” in Item 1A of this Annual Report, we discuss various factors that could adversely impact us and hinder our ability to achieve our projected results, including general economic factors and competition from the dominant brands in the QSR industry.

 

 

 

Share Repurchase Program

 

Share Repurchase Program.   Effective July 22, 2002, as amended on October 7, 2002, re-affirmed on May 27, 2005, and expanded on February 17, 2006 and June 27, 2006, the Company’s board of directors approved a share repurchase program of up to $165.0 million. The program, which is open-ended, allows the Company to repurchase shares of the Company’s common stock from time to time. During 2006 and 2005, the Company repurchased and retired 1,486,714 and 1,542,872 shares of common stock for approximately $20.3 million and $19.5 million, respectively, under this program.

 

From January 1, 2007 through February 25, 2007 (the end of the Company’s second period for 2007), the Company repurchased and retired an additional 136,400 shares of common stock for approximately $2.4 million. As of February 25, 2007, the maximum value of shares that may yet be repurchased under the program was $44.8 million. Pursuant to the terms of the Company’s 2005 Credit Facility, the Company is subject to a repurchase limit of approximately $7.3 million for the remainder of fiscal 2007.

 

Capital Expenditures

 

Our capital expenditures consist of re-imaging activities associated with company-operated restaurants, new restaurant construction and development, equipment replacements, the purchase of new equipment for our company-operated restaurants, investments in information technology, accounting systems and improvements at our corporate offices. Capital expenditures related to re-imaging activities consist of significant renovations, upgrades and improvements, which on a per restaurant basis typically cost between $70,000 and $160,000. Capital expenditures associated with new restaurant construction and rebuilding activities, typically cost, on a per restaurant basis, between $0.7 million and $1.0 million.

 

During 2006, we invested $7.0 million in various capital projects, including $2.6 million in repairs and replacement of equipment associated with hurricane-damaged restaurants, $1.6 million in new restaurant locations, $0.5 million in our re-imaging program, $1.7 million in other capital assets to maintain, replace and extend the lives of company-operated QSR equipment and facilities, and $0.6 million for information technology systems.

 

During 2005, we invested $4.2 million in various capital projects, including $0.6 million in repairs and replacement of equipment associated with hurricane-damaged restaurants, $1.9 million in new restaurant locations, $0.4 million in Popeyes corporate office renovations, $0.7 million in other capital assets to maintain, replace and extend the lives of company-operated QSR equipment and facilities, $0.2 million for information technology systems, and $0.4 million to complete other projects.

 

During 2004, we invested $25.4 million in various capital projects, including $11.6 million in new and relocated restaurant, bakery and cafe locations, $3.1 million in our re-imaging program, $4.2 million in other capital assets to maintain, replace and extend the lives of company-operated QSR equipment and facilities, $5.2 million for information technology systems, and $1.3 million to complete other projects.

 

Substantially all of our capital expenditures have been financed using cash provided from operating activities and borrowings under our bank credit facilities.

 

With respect to the rebuilding and refurbishment of hurricane-damaged restaurants, we expect capital expenditures of $1.0 to $1.5 million during 2007. We anticipate the building of 4 to 6 new company-operated restaurants during 2007, with associated capital expenditures of $4.0 to $6.0 million. As to all other capital expenditures during 2007 (for re-imagings, equipment upgrades, and information technology system upgrades), we expect such costs to range from $3.0 to $4.0 million.

 

Acquisition of Previously Franchised Restaurants

 

On May 1, 2006, we completed an acquisition of 13 previously franchised restaurants from a Popeyes franchisee in the Memphis and Nashville, Tennessee markets. The total consideration was $15.8 million consisting of (1) $9.3 million in cash, (2) $3.3 million of assumed long-term debt obligations, (3) $2.9 million in above market rent obligations, and (4) $0.3 million in legal and professional fees associated with the transaction. The acquired units provide regional diversity and additional company-operated test markets for our new menu items, promotional concepts and new restaurant designs for the benefit of the entire Popeyes system. The acquisition also provides a new market for growth of company-operated restaurants.

 

Effects of Hurricane Katrina and Insurance Proceeds

 

We maintain insurance coverage which provides for reimbursement from losses resulting from property damage, including flood, loss of product, and business interruption. Our insurance policy covering the hurricane damage entitles us to receive reimbursement for approximate replacement value for the damaged real and personal property as well as certain business interruption losses, net of applicable deductibles and subject to insurable limits. The insurance coverage is limited to $25.0 million, with a $10.0 million flood sub limit.

 

We have recorded a receivable for insurance recoveries to the extent losses have been incurred, and the realization of a related insurance claim, net of applicable deductibles, is probable. As of December 31, 2006, the Company has recognized insurance recovery receivables for $3.5 million in net book value write-downs for real property and equipment damages, $2.4 million of business interruption losses and other costs, and $0.3 million of

lost inventory. The Company’s insurance carriers have advanced $5.0 million against these and other claims made by the Company. The Company believes its estimated recoverable losses under the terms of its insurance policies will exceed the net book value of damaged assets and will exceed the insurance proceeds received to date. We are engaged in discussion with our insurance carriers and are unable to estimate the full amount of recovery.

 

Off-Balance Sheet Arrangements

 

SMS Indemnity Agreement.   In order to ensure favorable pricing for fresh chicken purchases and to maintain an adequate supply of fresh chicken for the Company and its Popeyes franchisees, SMS has entered into purchase contracts with chicken suppliers. The contracts which pertain to the vast majority of our system-wide purchases for Popeyes are “cost-plus” contracts that utilize prices based upon the cost of feed grains plus certain agreed upon non-feed and processing costs. These contracts include volume purchase commitments that are adjustable at the election of SMS (which is done in consultation with and under the direction of the Company and its Popeyes franchisees). In a given year, that year’s commitment may be adjusted by up to 10%, if notice is given within specified time frames; and the commitment levels for future years may be adjusted based on revised estimates of need, whether due to restaurant openings and closings, changes in SMS’s membership, changes in the business, or changes in general economic conditions.

 

The estimated minimum level of purchases under these contracts is $173.3 million for 2007 and $183.7 million for 2008. AFC has agreed to indemnify SMS for any shortfall between actual purchases by the Popeyes system and the annual purchase commitments entered into by SMS on behalf of the Popeyes restaurant system. The indemnification has not been recorded as an obligation in the Company’s balance sheets. The Company does not expect any material loss to result from the indemnification since we do not believe that performance, on our part, will be required.

 

AFC Loan Guarantee Programs.   In March 1999, we implemented a program to assist qualified current and prospective franchisees in obtaining the financing needed to purchase or develop franchised restaurants at competitive rates. Under the program, we guarantee up to 20% of the loan amount toward a maximum aggregate liability for the entire pool of $1.0 million. For loans within the pool, we assume a first loss risk until the maximum liability for the pool has been reached. Such guarantees typically extend for a three-year period. As of December 31, 2006, approximately $0.7 million was borrowed under this program, of which we were contingently liable for approximately $0.1 million in the event of default.

 

In November 2002, we implemented a second loan guarantee program to provide qualified franchisees with financing to fund new construction, re-imaging and facility upgrades. Under the program, we assume a first loss risk on the portfolio up to 10% of the sum of the original funded principal balances of all program loans. As of December 31, 2006, approximately $1.4 million was borrowed under this program, of which we were contingently liable for approximately $0.2 million in the event of default.

 

These loan guarantees have not been recorded as an obligation in our consolidated balance sheets. We do not expect any material loss to result from these guarantees because we do not believe that any indemnity under this agreement will be necessary.

 

Long Term Debt

 

2 005 Credit Facility.   On May 11, 2005, and as amended on April 14, 2006, we entered into a bank credit facility (the “2005 Credit Facility”) with J.P. Morgan Chase Bank and certain other lenders, which consists of a $60.0 million, five-year revolving credit facility and a six-year $190.0 million term loan.

 

The revolving credit facility and term loan bear interest based upon alternative indices (LIBOR, Federal Funds Effective Rate, Prime Rate and a Base CD rate) plus an applicable margin as specified in the facility. The margins on the revolving credit facility may fluctuate because of changes in certain financial leverage ratios and our compliance with applicable covenants of the 2005 Credit Facility. We also pay a quarterly commitment fee of 0.125% on the unused portions of the revolving credit facility.

 

At the closing of the 2005 Credit Facility, we drew the entire $190.0 million term loan and applied approximately $57.4 million of the proceeds to pay off the 2002 Credit Facility, to pay fees associated with that

facility, and to pay closing costs associated with the new facility. The remaining proceeds were used to fund a portion of our special cash dividend and for general corporate purposes.

 

The 2005 Credit Facility is secured by a first priority security interest in substantially all of our assets. The 2005 Credit Facility contains financial and other covenants, including covenants requiring us to maintain various financial ratios, limiting our ability to incur additional indebtedness, restricting the amount of capital expenditures that may be incurred, restricting the payment of cash dividends, and limiting the amount of debt which can be loaned to our franchisees or guaranteed on their behalf. This facility also limits our ability to engage in mergers or acquisitions, sell certain assets, repurchase our stock and enter into certain lease transactions. The 2005 Credit Facility includes customary events of default, including, but not limited to, the failure to pay any interest, principal or fees when due, the failure to perform certain covenant agreements, inaccurate or false representations or warranties, insolvency or bankruptcy, change of control, the occurrence of certain ERISA events and judgment defaults.

 

Under the terms of the revolving credit facility, we may obtain other short-term borrowings of up to $10.0 million and letters of credit up to $25.0 million. Collectively, these other borrowings and letters of credit may not exceed the amount of unused borrowings under the 2005 Credit Facility. As of December 31, 2006, we had $5.3 million of outstanding letters of credit. Availability for other short-term borrowings and letters of credit was $29.7 million.

 

In addition to the scheduled payments of principal on the term loan, at the end of each fiscal year, we are subject to mandatory prepayments in those situations when consolidated cash flows for the year, as defined pursuant to the terms of the facility, exceed specified amounts. Whenever any prepayment is made, subsequent scheduled payments of principal are ratably reduced.

 

As of December 31, 2006, we were in compliance with the financial and other covenants of the 2005 Credit Facility. As of December 31, 2006, the Company’s weighted average interest rate for all outstanding indebtedness under the 2005 Credit Facility, including the effect of the interest swap agreements, was approximately 6.6%.

 

2 005 Interest Rate Swap Agreements.   Effective May 12, 2005, we entered into two interest rate swap agreements with a combined notional amount of $130.0 million. Effective December 29, 2006, the Company reduced the notional amounts of the combined agreements to $110.0 million. The agreements terminate on June 30, 2008, or sooner under certain limited circumstances. The effective portion of the gain associated with the termination of the $20.0 million notional amount, approximately $0.3 million, will be amortized into interest expense over the remaining life of the hedge. Pursuant to these agreements, pay a fixed rate of interest and receive a floating rate of interest. The effect of the agreements is to limit the interest rate exposure on a portion of the 2005 Credit Facility to a fixed rate of 6.4%. During 2006, the net interest income associated with these agreements was $1.3 million. These agreements are accounted for as an effective cash flow hedge. At December 31, 2006, the fair value of these agreements was $1.6 million, which was recorded as a component of “other long term assets, net.” The changes in fair value are recognized in accumulated other comprehensive income in the Consolidated Balance Sheets.

 

Impact of Inflation

 

We believe that, over time, we generally have been able to pass along inflationary increases in our costs through increased prices of our menu items, and the effects of inflation on our net income historically have not been, and are not expected to be, materially adverse. Due to competitive pressures, however, increases in prices of menu items often lag behind inflationary increases in costs.

 

Tax Matters

 

We are continuously involved in U.S., state and local tax audits for income, franchise, property and sales and use taxes. In general, the statute of limitations remains open with respect to tax returns that were filed for each fiscal year after 2002. However, upon notice of a pending tax audit, we often agree to extend the statute of limitations to allow for complete and accurate tax audits to be performed.

 

Market Risk

 

We are exposed to market risk from changes in certain commodity prices, foreign currency exchange rates and interest rates. All of these market risks arise in the normal course of business, as we do not engage in speculative trading activities. The following analysis provides quantitative information regarding these risks.

 

Chicken Market Risk.   Fresh chicken is the principal raw material for our Popeyes operations. It constitutes more than 40% of our combined “restaurant food, beverages and packaging” costs. These costs are significantly affected by increases in the cost of chicken, which can result from a number of factors, including increases in the cost of grain, disease, declining market supply of fast-food sized chickens and other factors that affect availability, and greater international demand for domestic chicken products.

 

In order to ensure favorable pricing for fresh chicken purchases and to maintain an adequate supply of fresh chicken for AFC and its Popeyes franchisees, SMS (a not-for-profit purchasing cooperative) has entered into chicken purchasing contracts with chicken suppliers.

 

Foreign Currency Exchange Rate Risk.   We are exposed to currency risk from the potential changes in foreign currency rates that directly impact our revenues and cash flows from our international franchise operations. In 2006, franchise revenues from these operations represented approximately 8.8% of our total franchise revenues. For each of 2006, 2005 and 2004, foreign-sourced revenues represented 4.7%, 4.5% and 4.0% of our total revenues, respectively. As of December 31, 2006, approximately $0.7 million of our accounts receivable were denominated in foreign currencies.

 

Interest Rate Risk.   Our net exposure to interest rate risk consists of our borrowings under our 2005 Credit Facility. Borrowings made pursuant to that facility include interest rates that are benchmarked to U.S. and European short-term floating-rate interest rates. As of December 31, 2006, the balances outstanding under our 2005 Credit Facility totaled $130.0 million. The impact on our annual results of operations of a hypothetical one-point interest rate change on the outstanding balances under our 2005 Credit Facility would be approximately $0.2 million.

 

Critical Accounting Policies

 

Our significant accounting policies are presented in Note 2 to our Consolidated Financial Statements. Of our significant accounting policies, we believe the following involve a higher degree of risk, judgment and/or complexity. These policies involve estimations of the effect of matters that are inherently uncertain and may significantly impact our quarterly or annual results of operations or financial condition. Changes in the estimates and judgments could significantly affect our results of operations, financial condition and cash flows in future years.

 

Accounting Related to Hurricane Katrina.   As discussed at Note 16 to our Consolidated Financial Statements, during the last week of August 2005, the Company’s business operations in Louisiana, Mississippi, and Alabama were adversely impacted by Hurricane Katrina. As it relates to the operations of our company-operated restaurants segment, 36 restaurants were closed for at least one day as a result of the hurricane. Certain of the restaurants have been permanently closed and others remain temporarily closed.

 

The Company has recognized impairments associated with damaged restaurants in accordance with our policies for asset impairments discussed below. The Company has incurred several costs as a result of the hurricanes, including costs associated with our leasing arrangements for the adversely effected restaurants. The Company accounts for the future lease payments associated with idled facilities in accordance with EITF 01-10.

 

The Company maintains insurance coverage which provides for reimbursement from losses resulting from property damage, including flood, loss of product, and business interruption. The Company records a receivable for insurance recoveries to the extent losses have been incurred and the realization of a related insurance claim, net of applicable deductibles, is probable. Accruals for business interruption do not include certain amounts for which recovery under the insurance policy is uncertain.

 

The accounting for the above matters involves significant estimates by management. These estimates will be subject to revision as events proceed forward with the repopulating of New Orleans, the refurbishment of our restaurants, resolution of certain disputed lease provisions, and the processing of claims with our insurance carrier.

 

Consolidation of Variable Interest Entities.   In accordance with FIN 46R, we consolidate entities that we determine (1) to be a variable interest entity (“VIE”) and (2) AFC is that entity’s primary beneficiary. In the first quarter of 2004, upon adoption of FIN 46R, we evaluated several of our business relationships that indicated that the other party might be a VIE; and subsequent to that time we continue to evaluate various relationships as circumstances change. Determination of whether an entity is a VIE and whether we are its primary beneficiary involves the exercise of judgment. See Note 2 to the Consolidated Financial Statements for a discussion of our VIE relationships and the impact of consolidating certain VIEs.

 

Impairment of Long-Lived Assets.   We evaluate property and equipment for impairment on an annual basis (during the fourth quarter of each year) or when circumstances arise indicating that a particular asset may be impaired. For property and equipment at company-operated restaurants, we perform our annual impairment evaluation on a site-by-site basis. We evaluate restaurants using a “two-year history of operating losses” as our primary indicator of potential impairment. Based on the best information available, we write-down an impaired restaurant to its estimated fair market value, which becomes its new cost basis. We generally measure the estimated fair market value by discounting estimated future cash flows. In addition, when we decide to close a restaurant, it is reviewed for impairment and depreciable lives are adjusted. The impairment evaluation is based on the estimated cash flows from continuing use through the expected disposal date and the expected terminal value.

 

Impairment of Goodwill and Trademarks.   We evaluate goodwill and trademarks for impairment on an annual basis (during the fourth quarter of each year) or more frequently when circumstances arise indicating that a particular asset may be impaired. Our impairment evaluation includes a comparison of the fair value of our reporting units with their carrying value. Our reporting units are our business segments. Intangible assets, including goodwill, are allocated to each reporting unit. The estimated fair value of each reporting unit is the amount for which the reporting unit could be sold in a current transaction between willing parties. We estimate the fair value of our reporting units using a discounted cash flow model or market price, if available. The operating assumptions used in the discounted cash flow model are generally consistent with the reporting unit’s past performance and with the projections and assumptions that are used in our current operating plans. Such assumptions are subject to change as a result of changing economic and competitive conditions. If a reporting unit’s carrying value exceeds its fair value, goodwill and trademarks are written down to their implied fair value.

 

Allowances for Accounts and Notes Receivable and Contingent Liabilities.   We reserve a franchisee’s receivable balance based upon pre-defined aging criteria and upon the occurrence of other events that indicate that we may or may not collect the balance due. In the case of notes receivable, we perform this evaluation on a note-by-note basis, whereas this analysis is performed in the aggregate for accounts receivable. We evaluate our notes receivable for uncollectibility each reporting period, on a note-by-note basis. We provide for an allowance for uncollectibility based on such reviews. See Note 2 to the Consolidated Financial Statements for information concerning our allowance account for both accounts receivable and notes receivable.

 

With respect to contingent liabilities, we similarly reserve for such contingencies when we are able to assess that an expected loss is both probable and reasonably estimable.

 

Leases.   The Company accounts for leases in accordance with SFAS No. 13, Accounting for Leases , and other related authoritative guidance. When determining the lease term, the Company often includes option periods for which failure to renew the lease imposes a penalty on the Company in such an amount that a renewal appears, at the inception of the lease, to be reasonably assured. The primary penalty to which we are subject is the economic detriment associated with the existence of leasehold improvements which might be impaired if we choose not to continue the use of the leased property.

 

The Company records rent expense for leases that contain scheduled rent increases on a straight-line basis over the lease term, including any option periods considered in the determination of that lease term. Contingent rentals are generally based on sales levels in excess of stipulated amounts, and thus are not considered minimum lease payments and are included in rent expense as they accrue.

 

Deferred Tax Assets and Tax Reserves.   We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax

assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

 

We assess the likelihood that we will be able to recover our deferred tax assets. We consider historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If recovery is not likely, we increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We carried a valuation allowance on our deferred tax assets of $3.4 million and $1.9 million at December 31, 2006 and December 25, 2005, respectively, based on our view that it is more likely than not that we will not be able to take a tax benefit for certain state operating loss carryforwards which begin to expire in 2008.

 

As a matter of course, we are regularly audited by federal, state and foreign tax authorities. We provide reserves for potential exposures when we consider it probable that a taxing authority may take a sustainable position on a matter contrary to our position. We evaluate these reserves, including interest thereon, on a quarterly basis to ensure that they have been appropriately adjusted for events that may impact our ultimate payment for such exposures. Presently, we do not believe that we have any tax matters that could have a material adverse effect on our financial position, results of operations or liquidity.

 

See Note 19 to the Consolidated Financial Statements for a further discussion of our income taxes.

 

Accounting Standards Adopted in 2006

 

Effective December 26, 2005, the Company adopted SFAS No. 123(R), “Share-Based Payment” (“SFAS 123R”), which requires the measurement and recognition of compensation cost at fair value for all share-based payments, including stock options and restricted stock awards. The Company adopted SFAS 123R using the modified prospective transition method and, as a result, did not retroactively adjust results from prior periods. Under this transition method, stock-based compensation is recognized for: (1) expense related to the remaining non-vested portion of all stock awards granted prior to December 26, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) and the same straight-line attribution method used to determine the pro forma disclosures under SFAS 123; and (2) expense related to all stock awards granted on or subsequent to December 26, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. At December 31, 2006, the total compensation cost related to stock options granted to employees under the Company’s stock option plans but not yet recognized was approximately $2.6 million, net of forfeitures. This cost will be amortized on a straight-line basis over a weighted average period of 2.5 years. See Note 2 to the Consolidated Financial Statements for a discussion of the impact of adopting this accounting standard.

 

Effective December 26, 2005, the Company adopted FASB Staff Position No. 13-1, “Accounting for Rental Costs Incurred during a Construction Period” (“FSP 13-1”), which requires rental costs associated with ground or building operating leases that are incurred during a construction period be recognized as rental expense. The Company has historically expensed such rentals. Thus, there was no material impact upon adoption of FSP 13-1.

 

In the fourth quarter of 2006, the Company adopted Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”), which provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of materiality. The adoption of SAB No. 108 did not have a material impact on the Company’s consolidated financial statements.

 

Accounting Standards That We Have Not Yet Adopted

 

For a discussion of recently issued accounting standards that we have not yet adopted, see Note 3 to our Consolidated Financial Statements. That note is hereby incorporated by reference into this Item 7.

 

Information about market risk can be found in Item 7 of this report under the caption “Market Risk” and is hereby incorporated by reference into this Item 7A.

 

Our Consolidated Financial Statements can be found beginning on Page F-1 of this Annual Report and the relevant portions of those statements and the accompanying notes are hereby incorporated by reference into this Item 8.

 

None.

 

 

Disclosure controls and procedures are controls and other procedures of a registrant designed to ensure that information required to be disclosed by the registrant in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is properly recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include processes to accumulate and evaluate relevant information and communicate such information to a registrant’s management, including its principal executive and financial officers, as appropriate, to allow for timely decisions regarding required disclosures.

 

 

We evaluated the effectiveness of the design and operation of AFC’s disclosure controls and procedures as of the end of our fiscal year 2006, as required by Rule 13a-15 of the Exchange Act. This evaluation was carried out under the supervision and with the participation of our management, including our CEO and CFO.

 

Based on management’s assessment, the CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2006 to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

 

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a - 15(f) and 15d - 15(f) under the Exchange Act. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

 

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway

Commission in Internal Control-Integrated Framework . This evaluation was carried out under the supervision and with the participation of our management, including our CEO and CFO. Based on this assessment, management believes that as of December 31, 2006, the Company’s internal control over financial reporting is effective.

 

Grant Thornton, LLP, our independent registered public accounting firm that audited our consolidated financial statements included in this Annual Report, has issued an audit report on management’s assessment of the Company’s internal control over financial reporting. This report can be found in section (e) below.

 

 

During the fourth quarter of 2006, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

Board of Directors and

Shareholders of AFC Enterprises, Inc.

 

We have audited management’s assessment included in Management’s Report on Internal Controls Over Financial Reporting included in AFC Enterprises, Inc. and subsidiaries (the “Company”) Form 10-K for 2006, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the COSO. Also in our opinion, the Company maintained, in

all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the COSO.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2006 and December 25, 2005, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the years in the periods ended December 31, 2006 and December 25, 2005 and our report dated March 9, 2007 expressed an unqualified opinion on those financial statements.

 

 

Atlanta, Georgia

March 9, 2007

 

Employment Agreement with Frederick B. Beilstein III

 

On March 14, 2007, we entered into an employment agreement with Frederick B. Beilstein III that provides for the terms of Mr. Beilstein’s employment as interim Chief Executive Officer of the Company. The agreement provides for a term beginning March 19, 2007 and unless earlier terminated extending for an initial term of ninety days concluding on June 22, 2007. The term of the agreement may be extended for an additional 30 day period upon written notice to Mr. Beilstein by the Company. Thereafter, the agreement may be extended by mutual agreement of the Company and Mr. Beilstein. The employment agreement provides for a bi-weekly salary at the rate of $29,423. In addition, Mr. Beilstein is eligible to participate in our employee benefit plans. In the event of a termination without cause, Mr. Beilstein will be entitled to receive a payment equal to his salary due for the current term of the agreement at the time of termination less any amount for the current term that has been previously paid to Employee. The agreement also contains covenants regarding confidentiality and non-competition and dispute resolution clauses. A copy of the employment agreement with Mr. Beilstein is attached to this Form 10-K as Exhibit 10.55 and is incorporated herein by reference.

 

Employment Agreement with and Restricted Stock Grant to James W. Lyons

 

On March 14, 2007, we entered into an employment agreement with James W. Lyons that provides for the terms of Mr. Lyons employment as Chief Operating Officer of the Company and provides for a base salary of $300,000 per annum plus a $15,000 flex perk allowance. The initial term of the employment agreement is through December 28, 2008, with an automatic extension for successive one-year periods following the expiration of each term, unless the company or Mr. Lyons provide written notice of non-extension to the other at least thirty days prior to the expiration of the term of the agreement. The employment agreement provides for an annual incentive bonus that is based on our achievement of certain performance targets with a total target incentive pay of $180,000, fringe benefits and participation in our benefit plans. In the event of a termination without cause, Mr. Lyons will be entitled to receive an amount equal to one times his annual base salary and target incentive bonus for the year in which the termination occurs and the acceleration of any unvested rights under any stock options or other equity incentive programs. If there is a change in control (as defined in the employment agreement) and within one year of the change in control, Mr. Lyon’s employment is terminated without cause, or there is a material diminution of or change in Mr. Lyon’s responsibilities, duties or title, Mr. Lyons may terminate his employment and receive the same severance he would have received upon a termination without cause. The agreement also contains covenants regarding confidentiality and non-competition and dispute resolution clauses. A copy of the employment agreement with Mr. Lyons is attached to this Form 10-K as Exhibit 10.56 and is incorporated herein by reference.

 

Pursuant to the employment agreement with Mr. Lyons, on March 14, 2007, the Company granted to Mr. Lyons 10,000 shares of restricted stock. The restricted stock vests over three years, with one-third vesting on each anniversary date of the grant.

Employment Agreement with Robert Calderin

 

On March 14, 2007, we entered into an employment agreement with Robert Calderin that provides for the terms of Mr. Calderin’s employment as Chief Marketing Officer of the Company and provides for a base salary of $285,137 per annum plus a $15,000 flex perk allowance. The agreement provides for an initial term through December 28, 2008, with an automatic extension for successive one-year periods following the expiration of each term, unless the Company or Mr. Calderin provide written notice of non-extension to the other at least thirty days prior to the expiration of the term of the agreement. The employment agreement provides for an annual incentive bonus that is based on our achievement of certain performance targets with a total target incentive pay of $128,312, fringe benefits and participation in our benefit plans. In the event of a termination without cause, Mr. Calderin will be entitled to receive an amount equal to one times his annual base salary and target incentive bonus for the year in which the termination occurs and the acceleration of any unvested rights under any stock options or other equity incentive programs. If there is a change in control (as defined in the employment agreement) and within one year of the change in control, Mr. Calderin’s employment is terminated without cause, or there is a material diminution of or change in Mr. Calderin’s responsibilities, duties or title, Mr. Calderin may terminate his employment and receive the same severance he would have received upon a termination without cause. The agreement also contains covenants regarding confidentiality and non-competition and dispute resolution clauses. A copy of the employment agreement with Mr. Calderin is attached to this Form 10-K as Exhibit 10.57 and is incorporated herein by reference.

 

Amendment to Employment Agreement with Frank J. Belatti

 

On March 14, 2007, we entered into an amendment (the “First Amendment”) to the employment agreement dated August 31, 2005 by and between the Company and Frank J. Belatti (the “Agreement”). The First Amendment eliminates Section 9.02 of the Agreement which previously provided for reimbursement of certain business expenses. A copy of the First Amendment is attached to this Form 10-K as Exhibit 10.58 and is incorporated herein by reference.

 

Information regarding our directors, executive officers, audit committee and our audit committee financial expert required by this Item 10 is included in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders and such disclosure is incorporated herein by reference. Biographical information on our executive officers is contained in Item 4A of this Annual Report on Form 10-K and is incorporated herein by reference.

 

We have adopted an Honor Code that applies to our directors and all of our employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A copy of the Honor Code is available on our website at www.afce.com. Copies will be furnished upon request. You may mail your requests to the following address: Attn: Office of General Counsel, 5555 Glenridge Connector, NE, Suite 300, Atlanta GA, 30342. If we make any amendments to the Honor Code other than technical, administrative, or other non-substantive amendments, or grant any waivers, from the Honor Code, we will disclose the nature of the amendment or waiver, its effective date and to who it applies on our website or in a report on Form 8-K filed with the SEC.

 

Information regarding executive compensation required by this Item 11 is included in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders and such disclosure is incorporated herein by reference.

 

Information regarding security ownership of certain beneficial owners and management and related stockholder matters required by this Item 12 is included in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders and such disclosure is incorporated herein by reference.

 

Information regarding certain relationships and related transactions, and director independence required by this Item 13 is included in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders and such disclosure is incorporated herein by reference.

 

The Company’s independent registered public accounting firm is Grant Thornton LLP. Information regarding principal accountant fees and services required by this Item 14 is included in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders and such disclosure is incorporated herein by reference.

 

The Company’s former independent registered public accounting firm was KPMG LLP (“KPMG”). AFC has agreed to indemnify and hold KPMG harmless against and from any and all legal costs and expenses incurred by KPMG in successful defense of any legal action or proceeding that arises as a result of KPMG’s consent to the inclusion of its audit report on AFC’s past financial statements.

 

 

The following consolidated financial statements appear beginning on Page F-1 of the report:

 

 

We have omitted all other schedules because the conditions requiring their filing do not exist or because the required information appears in our Consolidated Financial Statements, including the notes to those statements.

 

 

 

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 14th day of March 2007.

 

AFC ENTERPRISES, INC.

 

Kenneth L. Keymer

Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.